Using Budgets Effectively (Cambridge (CIE) A Level Business): Revision Note

An introduction to budgets

• A budget is a financial plan that a business (or department in the business) sets regarding costs and revenue

  • The budget is usually closely aligned with the business objectives

Measuring performance with budgets

Measuring overall business performance

• Budgets allow managers to assess how well the whole business is performing

  • Compare actual income and expenses with budgeted figures to identify profit levels, cost control, or overspending

  • Helps judge if the business is meeting its financial goals, such as revenue targets or profit margins

  • Variances help explain good or poor performance

Measuring functional performance

• Each function, e.g. marketing, operations, HR, usually has its own budget

  • Comparing actual department spending and results with the budget shows how well each area is performing

  • Helps hold managers accountable for cost control and meeting targets

  • Encourages efficient use of resources within each function

Comparing performance over time

• Budgets help track performance year-on-year or month-on-month

• Businesses can spot trends, such as rising costs or improving efficiency

• Helps with long-term planning and forecasting

Comparing performance across functions

• Budgets help compare different departments at the same time, even if their roles are different

• This supports fair decision-making on things like bonuses, promotions or extra funding

Types of budgets

1. Incremental budgets

• An incremental budget is based on last year’s figures, with small adjustments made to reflect expected changes

  • Changes could include inflation, wage rises or modest increases in sales and costs

Evaluating the use of incremental budgets

2. Flexible budgets

• A flexible budget is adjusted depending on the level of output or sales

  • Instead of using one fixed figure, it shows what income and expenses should look like at different levels of activity

Evaluating the use of flexible budgets

3. Zero budgeting

• Zero budgeting is when every department or manager must justify all spending

  • Rather than using the previous year’s budget as a starting point, each cost must be reviewed and approved individually

Evaluating the use of zero budgeting

The use of budgets

• Budgets can play an important role in the day-to-day management of a business

• They help with planning, decision-making, control, and monitoring of non-financial performance

Ways budgets are used

Allocating resources

• Budgets help businesses decide where money and resources should be focused

• Each department receives funding based on its needs and priorities, ensuring efficient use

Control within a business

• Budgets set clear financial limits to help prevent overspending

• Managers are accountable for staying within their budget, which improves discipline and control

Monitoring non-financial performance

• Budgets can track spending on non-financial goals like customer service, training, or sustainability

• This ensures resources support wider business objectives

Variances

• Once budgets have been set, managers carry out variance analysis to compare actual performance to the targets set in the budget

  • A budget variance is a difference between the figure budgeted and the actual figure achieved by the end of the budgetary period

• Variance analysis seeks to determine the reasons for the differences between the actual figures and the budgeted figures

Types of variance

Calculating and interpreting variances

• A budget variance is calculated by subtracting the budgeted figure from the actual figure

Evaluating budgets

• Budgets can be useful management tools because they help maintain financial control by monitoring income and expenditure

  • This allows managers to spot potential overspending or cash flow problems early

• Budgets also help measure performance by setting financial targets that can be compared with actual results

  • This makes it easier to assess how well a department or the whole business is performing and whether corrective action is needed.

• However, budgets are based on forecasts and assumptions, which means managers make inappropriate decisions if market conditions change or if estimates are wrong

• Strict budgets may reduce flexibility

  • Managers may feel restricted and unable to respond quickly to unexpected opportunities or urgent problems if they are required to stick closely to a fixed spending plan

Advantages and disadvantages of budgeting